Easing of Government Restrictions Allows Funding Syndicates Such as AngelList to Flourish

When entrepreneur
Jakub Krzych
raised seed funding for his first technology startup in 2009, it took him around six months to scrounge together $20,000. A few weeks ago, Mr. Krzych rounded up $250,000 in just three days for his second startup, called Estimote.

What changed? An easing on some of the U.S. government's long-standing restrictions on fundraising has given life to a new type of venture-financing vehicle called an online syndicate, that allows so-called "angel" or early-stage investors to quickly assemble a group of investors over the Internet.

Startups can still take money only from wealthy, verified investors, but the new rules eliminate a ban on "general solicitation," meaning companies can now publicly market their fundraising efforts on their blog, on Twitter, or on syndicate services such as AngelList, which has tens of thousands of potential backers.

"This blows open the doors" to investing, says
John Borthwick
,
chief executive of Betaworks, a New York-based seed investor and digital media company that put $100,000 of its own money into Estimote and raised $150,000 from other backers through a syndicate deal on AngelList.

Here's how an AngelList syndicate works: A person or firm forms a group that individual investors can join. These individuals select how much they want to contribute, while the leader of the syndicate decides which of them to accept or reject. The syndicator has a 10% to 20% claim on future profits of the deal, and gives 5% of this to AngelList.

A syndicate can be formed for a one-time deal or for multiple investments. Backers get access to the syndicator's deal flow and don't have to pay a management fee, unlike traditional venture funds.

Advocates believe that by enabling a single person or firm to rapidly amass a large amount of capital, syndicates could democratize private company investing and disrupt the old boys club of venture capital. While Betaworks had previously required participants in its offline syndicate deals to put up at least $25,000, the ease of attracting investors online allowed it to lower that minimum to $2,500. "It most definitely increases access to capital," says Mr. Borthwick.

Not just any would-be angel can set up a syndicate: They are vetted by AngelList, which favors angels with a track record and net worth of $2 million or more. AngelList CEO Naval Ravikant says its system also favors angels with strong reputations, and that his service makes sure that investors, who transact on the site, are accredited.

Still, skeptics worry that the rise of syndicates could help fan another investing bubble and lure a new class of investors who could easily lose their money or even be fleeced by fraudsters. Mr. Ravikant says the company may further stiffen its requirements, given that early-stage investing is already a risky game for the pros.

"It's highly understood that a lot of people will lose money," says
Keith Rabois,
a partner at Khosla Ventures and an early adviser of AngelList. "There's a lot of superficial allure, but it's a pretty poor economic decision."

Founders like
Jonathan Palley,
CEO of wearable device maker Spire Inc. are already using AngelList to bypass venture capital entirely. After raising $750,000 from his personal network, one of Mr. Palley's investors,
Jeff Schox,
suggested using a syndicate to raise more. Mr. Schox, an owner of a boutique patent firm, organized the syndicate on AngelList and soon raised another $250,000 for Spire.

When the laws governing marketing changed, the syndicate was able to attract another $60,000 within the first three hours. Mr. Palley ended up accepting about $310,000 for this add-on round—and thanks to the high demand, he is now marketing a new fundraising round with the aim of raising another half a million dollars. "I now tell people, we should have made AngelList a core part of our plans from the get go," he says.

There are now 85 syndicates on AngelList. Though many are individual investors, investment firms—such as Estimote partner Betaworks—are also dipping in their toes to test the new platform.

The syndicate for Estimote attracted first-time investors like
Mike Dudas,
a manager at online payments company Braintree Payment Solutions. Mr. Dudas says he couldn't afford to get into deals before AngelList. "With a $2,500 check they would not talk to me," he says.

He didn't get any financial or nonpublic information about Estimote, but chose to invest based on the reputation of Betaworks and his knowledge of the market for retail technology. He says he expects to invest $50,000 to $75,000 in a few dozen deals over the next 5 years.

More traditional venture firms are testing the waters, too. Brad Feld, a managing director of the Foundry Group, a Boulder, Colorado-based venture firm, has created a syndicate under AngelList called FG Angels that has attracted 140 backers, and could invest $285,201 in future deals. Mr. Feld says he is planning to make 50 investments through FG Angels, mostly in deals that fall outside of its current strategy. FG Angels is funded by capital from Foundry's existing funds.

Matt Murphy, a partner at Silicon Valley venture firm Kleiner Perkins Caufield & Byers, says syndicates won't threaten traditional firms since venture firms still have their advantages, such as the ability to invest tens of millions at a time, offer networks of advisers, and provide the ability to invest additional capital in future rounds.

However, he thinks syndicates could disrupt the clubby world of angel investors where angels often refer deals to each other, since the profit incentive may lead them to head their own syndicate and not invite other angels into a deal.

New York angel investor
David Tisch
says he has lost some sleep over Web syndication. So far, he has declined to form one of his own, but he has backed four syndicates.

Mr. Tisch says he thinks he'll be OK, but he may have to market his name more aggressively. "I might need to get louder," he says.

In 2012, 95% of startups were funded by angels. We will see more of it this year. This is an age of angels. Angel activity in New York city is bubbling with activity like no other city in the world. With the JOBS Act, entrepreneurs will be able to reach out to more investors.

The traditional methods of building businesses is morphing and this is one where startups and businesses have more options. AngelList has been doing pretty well already funding technology startups. The model is very interesting; one would be on the lookout on how this would disrupt startup funding.

Joining angel networks lessen the high risk involved by pooling their investment capital and sharing knowledge and expertise. This year's trends sees angel networks leveraging and embracing crowdfunding with the legalization of equity crowdfunding in the U.S.

This copy is for your personal, non-commercial use only. Distribution and use of this material are governed by our Subscriber Agreement and by copyright law. For non-personal use or to order multiple copies, please contact Dow Jones Reprints at 1-800-843-0008 or visit www.djreprints.com.